accountants guide to grantor trusts 111714

ACCOUNTANTS’ GUIDE TO GRANTOR TRUSTS

Naperville, Illinois

November 17, 2014

1Copyright 2014 Frost, Ruttenberg & Rothblatt, P.C.

All Rights Reserved

Scott M. Pohar

Frost, Ruttenberg & Rothblatt, P.C.

[email protected]

847/282-6324 Phone and Fax

www.frrCPAs.com

NBINATIONAL

BUSINESS

INSTITUTE TM

Outline of what we will discuss

A. Current Federal and State Tax Regimes.

B. Calculating Taxable Income

C. Accounting Income vs. Taxable Income

D. Grantor Tax Information Letter

E. Reporting Trust Income1. Using Form 1099 instead of Form 1041

2. When must you file a 1041?

3. How to report trust income on grantor’s Form 1040.

4. Estate Form 1041 (Pre and Post Death)

5. Beneficiary Reporting 1040/1041.

F. How to change from Form 1041 to 1099.

G. Pease limitations on Itemized deductions, 3.8% Surtax and Other

individual tax changes that may affect Grantor Trust Taxation.


All Rights Reserved

Advantages of Grantor Trusts

• Helps to avoid probate.

• Can avoid guardianship in cases where all assets are

held in trust.

• Can trap income to the grantor, while growing the

assets free of estate tax.

• Can be an asset protection vehicle in some cases.

(Irrevocable Grantor Trusts)

• May help trust to achieve non-passive status under the

3.8% net investment income tax.

Copyright 2014 Frost, Ruttenberg & Rothblatt, P.C. All

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Must you file grantor trust returns in

States?

• If you have chosen the option to file a Form 1041

instead of the alternative options, then usually you

must file a return in the state or states where you have

source income, or are a resident.

• Many exceptions to the above rule.– IL does not require the filing of a grantor trust.

– Some states have rules to file if the income is greater than an

amount.

– Must look to the instructions for the various states if you have source

income to that state, or the trust is a resident of that state.

– Be careful with regards to residency. Some states are based on

where the trustee is located, or where the trust is formed, and some

are based on where the beneficiary lives.Copyright 2014 Frost, Ruttenberg & Rothblatt, P.C. All

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Calculating Taxable Income

• Trusts generally follow similar rules to an individual

return, however, it can be like a partnership if the

income is distributed to the beneficiaries or a mixture

of the two.

• The income of grantor trusts is taxed on a gross basis

to the “grantor”.

• Grantor trust rules are in the code under sections 671-

678.

• Non-grantor trusts are tax on a net basis – Income is

netted against deductions and taxed or distributed

proportionately.Copyright 2014 Frost, Ruttenberg & Rothblatt, P.C. All

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(continued)

• Non-grantor trusts have different exemptions as

follows:– Complex Trust (Usually $100, but can be $300 if certain

requirements are met)

– Simple Trust $300

– Estates $600

• Capital Gains are usually taxed to the trust- Should review the trust agreement to see if gains can be allocated to

income

- Can’t pass out capital losses except in a final return

.


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(continued)

• Expenses:• Grantor trusts are displayed on the grantor letter in total and then

reported by the Grantor on his/her individual tax return in the proper place

• Expenses Non-grantor trusts:– Some expenses, like attorney and accountant fees, are not subject to

2% of AGI. Other examples include casualty and theft and domestic

production deduction.

– Only expenses for the production or collection of income is subject to the

2% of AGI Limitation.

– Expenses are netted when allocating income to the beneficiary.

(This reporting does not further limit the deductions under the limitation

of itemized deductions, Pease rule)


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Accounting Income vs. Taxable Income

• Trust accounting income is a concept that is

sometimes misunderstood amongst trustees.– It is a cash basis concept focusing on cash receipts and disbursements.

– Can be governed by the trust agreement.

– If no mention in the trust agreement, look to state Principal and Income

statutes to determine what is income and principal.

– Does not apply to the taxation of grantor trusts, but can apply to the

distributions from grantor trusts. So a defective grantor trust will have

specific language regarding distribution provisions, which must be

followed and which will have a definition of what is income and what is

principal.

– What if the trust is only part grantor trust?

– See list of income and principal under IL code in book


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Requirements to file a trust return

(all trusts)

• Domestic Trust

• At least $600 of gross income

• ANY taxable income or

• A non-resident alien beneficiary

• A Grantor trust, has no exemption and all deductions

pass through as deductions instead of as a net

amount so any income is considered taxable.

• If you are going to file a Form 1041, get an EIN when

formed.


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What types of grantor trusts require

you to file a Form 1041?

• If all income is reported in an EIN. I see no reason to

use the 1099 method, and so I always prepare a

grantor return when the income is reported in EIN.

• If return is partially grantor, you will need to file a

grantor letter with the return. Examples include a

QSST, or whereall income is grantor, but principal is

not.

• Grantor Type Charitable Lead Trust(CLT) (You will

also need to prepare a Form 5227)

• Trusts with more than 1 grantor, exception being a

husband and wife.Copyright 2014 Frost, Ruttenberg & Rothblatt, P.C. All

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What types of grantor trusts require you to

file a Form 1041?

(Continued)

• A foreign trust.

• A common trust fund (almost no longer used)

• A trust where the grantor is not a US Citizen.

• The grantor must be on a calendar year end. Since a

grantor trust must be on the same year end as the

grantor, and if the grantor is on a fiscal year, then a

trust return must be filed to report the income.

• Check with attorney to see if there is another reason to

file the return. Some attorneys believe that asset

protection is a good reason to file a separate return.


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What are the Alternative Reporting

Methods?

• No return method

• 1099 method


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1099 Alternative Method

• 1099s in the EIN of the trust are then reported on a

1099 in the name and SSN of the Grantor.

• Trustee must also give a list of expenses to the

Grantor incurred by the trust.

• Trustee who is not a grantor must produce a report

showing the income and expenses.

• Hardly ever used since most believe you can just as

easily file a Form 1041 as a separate 1099.


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Reporting in SSN of Grantor

(No return method)

• Give payors of income the SSN of the grantor and the

name of the trust as the owner.

• Give them a W-9 if required.

• All income will be reported in the SSN of the grantor.

• Trustee, if other than the grantor, should provide a

report of income and expense for the year paid by the

trust.


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Form 1041 Filed

• If you haven’t elected an alternative filing procedure

then file a Form 1041.

• Due date is 3 ½ months after the

• Page 1, shows grantor trust language if only a grantor

trust.

• If the trust is part grantor trust, then file either a simple

or complex then add the grantor letter to the back. In

this case you will need to check multiple boxes.

• Some states don’t require a Form 1041 to be filed, like

IL.


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Form 1041 Filed

• Section 179 expense is normally not deductible by a

trust. However, a grantor trust is considered a pass-

through entity so it can be deducted by the individual

flowing through a grantor trust.


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How to report the income on the

Grantor’s Individual Return

• Reporting can be slightly different depending on

whether you have elected the alternative reporting or

filing a 1041.

• Interest and dividends will be reported on Schedule B.

• Capital gains on schedule D. If I file a 1041 and show

the itemized sales, then I don’t report them the same

on the 1040. If you are just getting a 1099, then you

will report as if they are owned by the individual.


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Form 1040 reporting

• Section 121 exclusion for selling the principal

residence, may or may not be available. If it is a

revocable grantor trust, then you can use the

exclusion. If it is irrevocable, like in a QPRT, the

exclusion is not available. If the trust is a grantor trust

under Section 678, this might allow you to use the

gain exclusion.

• K-1s, many times we attach a statement to the return

to indicate the attached K-1s will be reported on the

grantors income tax return. Then we report the K-1 on

Schedule E.


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What happens when someone dies?

• Get new EIN for the trust.

• Determine if you will elect Section 645 to report the

grantor trust as part of the estate.

• Determine what tax year to then report the income

realizing you can’t go more than 1 year past death.

• Income and expenses need to be split between pre

and post death for tax reporting. Sometimes we

allocate based on the number of days in the year, but

we usually try and do better by getting a broker

statement as of the month of death.


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(Continued)

• If the trust contains assets of the survivor spouse, then you

will split off the survivor assets into a separate survivor’s

grantor trust. This can happen when the attorney sets up a

Joint Grantor Trust, or in a community property state, like

California.

• Normally, the successor trusts, which usually aren’t grantor

trusts, will split into a family trust and/or a marital trust. The

marital trust could be a grantor trust if the surviving spouse

has a general power of appointment over the trust both

during life and at death, or if she has an unlimited power to

apppoint income and/or principal to herself as trustee.


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(Possible 645 Election)

• You will need to determine if you want to make a 645

election for the trust. Under IRC Section 645, the

grantor trust and the “administrative trust” can be

combined into one return after death. The benefits of

making a 645 election are:– Fiscal Year

– One return if you have assets in the estate and the trust

– Can continue to own S-corp stock during the estate administration

– Can take a charitable set-aside deduction only allowed to estates.

– Push income to a later tax year.

– No estimates for two years


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(Possible 645 Election)

• This is can be a very powerful election, especially if

you have IRD or can take a charitable set-aside.

However, there are some negative impacts so we use

it sparingly:– More difficult to prepare return (1099s aren’t enough information)

– Must end after estate administration:

• Lesser of two years or 6 months after estate is settled by a

closing letter

- Will have to file two tax returns in one year if trusts are funded


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Case Study showing Reporting difference

between individual and trust

Individual Return (Grantor Trust)

Schedule A Taxes $12,500.

Schedule A Misc Expense(2%) $14,000.

Schedule B Interest $2,500.

Schedule B Dividends $3,000.

Schedule D – Short Term $25,000.

Schedule D – Long Term $29,500.


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Case Study showing Reporting difference

between individual and trust

Tax Reporting if a non-grantor trust to individual:

No Income will be reported to a beneficiary since the

expenses would wipe out all Distributable Net Income

(DNI). Actually if Income or Principal distributions

were made, the K-1 would show an AMT Adjustment

of $5,500.

Tax to Trust (Assuming Capital Gains are not DNI):

Short Term Gain $ 4,000.

Long Term Gain $29,500.


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How to change the Grantor Trust

reporting method from 1041 to No return

• Notify the payors of income to change the EIN to the

SSN of the grantor. Leave the name of the trust as

the owner.

• File a Final Form 1041 using the EIN of the trust by

checking the final return box on page 1 of 1041.

• Attach a statement to the final return stating:

– “Pursuant to Reg. 1.671-4(g), this is the final Form 1041 for this

grantor trust.”


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How to change the Grantor Trust

reporting method from No return to 1041

• Apply for new EIN.

• Notify payors of income of the new EIN and provide

them with a Form W-9.

• File a Form 1041 with the “initial return” box checked.


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Tax affects of various items on

Grantor Trusts

• Pease Limitation: This has no affect on any trusts

including grantor trusts. It only affects the itemized

deductions of individual returns. If the individual is

being taxed from a trust, and it doesn’t have to be a

Grantor Trust, then itemized deductions net against

income and so can avoid the Pease Limitation.

• Net Investment Income Tax: Grantor trusts are not

subject to the new NII tax under the affordable care

act. Non-Grantor trusts are affected over the $11,950

of taxable income (Trusts highest tax bracket)


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accountants guide to grantor trusts 111714

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